Stewart’s Shops Corporation (“Stewart’s Shops”) owns and operates more than 300 convenience stores and gas stations in New York and Vermont. In 2003, Stewart’s Shops formed a captive insurance subsidiary called Black Ridge Insurance Corporation (BRIC). In 1997, the New York Legislature enacted legislation providing for captive insurance companies to be created and operated in New York. Under those statutes, captive insurance companies would be subject to gross premium taxes.
BRIC was formed under these statutes and was regulated by the New York Department of Insurance (“Department”). In fact, Stewart’s Shops was encouraged by the captive unit of the New York Department of Insurance to form the captive. In addition, the Department recommended a firm to perform a feasibility and actuarial study to assist with the formation and license application for BRIC. The study concluded that the risks to be insured were traditional business risks and recommended appropriate premiums based on current market conditions. The Department accepted BRIC’s application, and BRIC began operations, collecting premiums and paying claims. It would appear that Stewart’s Shops’ risk management project was successfully and appropriately implemented.
However, in 2010 and 2011, the New York Division of Taxation (“Division”) conducted an audit of Stewart’s Shops and concluded that the payments from Stewart’s Shops to BRIC were not allowable. The Division asserted that the payments were not deductible premiums for determining federal taxable income (FTI). The Division’s position was that because there was neither risk shifting nor distribution of risk, the payments could not be considered deductible premiums. These elements are essential for federal tax purposes to ensure the deductibility of payments as premiums. The New York Tax Appeals Tribunal1 agreed with an Administrative Law Judge who determined that the deduction should be disallowed despite the recognition of BRIC as an insurance company for purposes of New York insurance law.
It would appear that Stewart’s Shops did everything right in establishing BRIC, and that BRIC was an insurance company under New York insurance law. But for tax purposes, not only does an insurance company need to meet the requirements of state insurance laws, it must also be considered an insurance company for federal income tax purposes, if the state uses FTI as the starting point for determining state income tax. If it had included enough additional parties and their related risks in BRIC, the diversification of risk requirements would have been satisfied, and the deductions would have been allowed. See IRS Rev. Rul. 2002-90, which delineated how risk shifting can occur within an affiliated group of companies.
1 Matter of Stewart’s Shops Corp., DTA No. 825745, July 27, 2017.
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